Crack Down

Cheating on taxes is getting a lot more difficult for Maryland liquor retailers.

The Comptroller of Maryland's alcohol audit project is drastically changing the way the state audits businesses. Liquor retailers are the first industry targeted by the new approach, and the program, implemented in 2002, has uncovered more than $27 million in unpaid taxes, including interest and penalties.

Only Worcester, Washington and Prince George counties, as well as the city of Baltimore, have been audited so far. Twenty more counties remain.

Collecting the Data
The 1998 election of William Schaefer as comptroller was the impetus for the alcohol audit project. His transition team recommended that an auditor be trained as a computer audit specialist, and Thomas Tartal -- field audit manager of the Comptroller's Office -- was tagged for the job. Tartal entered a six-month course at the University of North Texas to learn computerized auditing, programming and statistical analysis.

Management in the compliance division of the Comptroller's Office began brainstorming ways to utilize Tartal's new skills. He was called in for a meeting and told to find out if liquor wholesalers' deliveries reconciled with their customers' tax returns.

Tartal's job was to figure out a way to do it.

The Comptroller's Office persuaded all 74 liquor wholesalers in Maryland to hand over sales records of transactions done with retailers in the state. Auditors compared the wholesale records with the sales their customers reported in tax returns. Auditing software purchased from ACL Services was used to juxtapose the two sides, revealing underreported sales from some retailers.

"Thanks to cooperation from the alcoholic beverage industry, we can compare product deliveries to liquor stores and what they, in turn, report as sales," Schaefer said in a statement. "As a result, we have found outright fraud in nearly half the cases we've audited, with some businesses grossly underreporting sales taxes. We're constantly on the lookout, so we may be coming to a bar or liquor store near you."

Kevin Kane, media relations officer for the Comptroller's Office, said liquor wholesalers preferred to give delivery information one county at a time.
"There was a concern that if the information was provided for the whole state at one time, we might come back again at a later date and ask for the same information, and their programming personnel would be tied up a second time," Kane said.

Sorting Out the Mess
Liquor wholesalers submitted their delivery data to Tartal in the form of Excel files, report files and flat files. The latter two are used to deliver data free of format idiosyncrasies linked to the programs where they originated. Tartal compiled the data into one master Excel file.

Auditors deleted every punctuation mark and made all cells the same size. At this point, the data was ready to be loaded into auditing software.

There were more than 1,200 businesses in Baltimore, and each bought from more than one wholesaler. Tartal decided the easiest way to untangle the mess of businesses was to start with registration numbers. Each wholesaler had a registration number that, in theory, would match with the registration number reported by each retailer.

The problem was several retailers failed to include those registration numbers in their tax returns. The ones that did, Tartal matched up and saved to a file. For the remaining unmatched retailers, he used the wholesaler corporate names found on the retailers' tax returns to place them in the correct columns.

"I ultimately matched each business with the proper registration," Tartal said.

He added one more column to the setup, computing the difference between the wholesalers' deliveries and the sales reported by the retailers. Everything was in place, and it was finally time to find discrepancies.

Baltimore retailers slighted Maryland nearly $3.5 million, according to the audit's results chart. Prince George County retailers shorted the state more than $6.2 million; Worcester County retailers scammed more than $800,000; and Washington County retailers swindled more than $180,000. Each of these incurred interest and penalties totaling more than $27 million owed the state of Maryland.

These numbers, high as they are, only represent 2 percent of the retailers reviewed in those counties, according to Tartal.

No revenue predictions have been made as to the full amount of unpaid taxes after the auditors sweep the entire state. Tartal said the audit results varied too much between counties to assemble a meaningful estimate.

Once They're Caught
Fraud in Maryland typically results in a penalty of 100 percent of the tax due, and a waiver of the normal statute of limitations of four years. Gross negligence also cancels the statute of limitations, resulting in a 10 percent penalty on assessments. The Comptroller's Office said some retailers would likely have to reimburse unpaid taxes spanning back to the early 1990s.

"The vast majority of alcohol retailers in this state are law-abiding businesses that turn in the sales taxes they collect," Schaefer said. "But the few that don't are cheating their customers and the state. We have every intention of finding out who they are, and we now have a way to do that."

Schaefer's 97 audits have turned up 51 cases of fraud and 22 cases of gross negligence, according to the Comptroller's Office. The remaining 24 audits were assessed in the normal fashion without any fraud or gross negligence penalties, according to Kane.

Kane said unless an accused retailer's audit is found to be in error by the courts, the Comptroller's Office is seeking the full amount of back taxes from each retailer.

"Audit findings are subject to appeal and there is generally no collection action taken until an audit is final," Kane said.

In most cases, the courts have found in the state's favor, according to Tartal.

Kane said the Comptroller's Office would allow the retailers to enter payment plans. These will be arranged on a case-by-case basis, depending on what the taxpayers owe and their ability to pay.

Their problem, however, may not end with the state of Maryland.

Kane said the IRS has contacted the Comptroller's Office about the alcohol audit project. The IRS Media Relations Office said it could not comment on any possible federal audits resulting from Maryland's program.

Tartal noted that many retailers reported their sales accurately to the IRS, while underreporting them to the state.

"In some cases, the business owner compiled and submitted their own sales tax return, and had a paid preparer to compile their federal income tax return," Tartal said.

Growing Use
Kinney Poynter, executive director of the National Association of State Auditors, Comptrollers and Treasurers, said this type of comparative auditing has surged in government over the past four years. His organization now offers sessions on the topic in all its seminars.

"The use of technology continues to increase because auditors are asked to do more with fewer people," Poynter said.

He said the New York Comptroller's Office is using similar technology to track Medicaid double charging in hospitals, which auditors can spot in less than one hour using software, according to Poynter.

"I don't want to say that it's intentional," Poynter said. "It could be just a simple error, but that's what's happening."

He said auditors should expect their use of technology to rapidly increase in the coming years. "It's the only way you can continue to do audits in the current environment."